Q: Can you explain what supra pro-rata is? It seems to be showing up in some VC term sheets now. What’s the impact on the entrepreneur? How hard should one try to negotiate it out? If a VC insists on this term, should the entrepreneur walk away?

Investors who want to increase their ownership drive down your valuation.

They are at odds with the founders and management who are trying to increase the next round’s valuation. These investors can exercise their protective provisions to veto everything but the lowest valuation offer. Or they can signal the “correct” valuation to new investors:

If the current investors want to increase their percent ownership, the valuation is too low. If they don’t want to increase their percent ownership, the valuation is too high. This makes it harder to get a high valuation since the new investors often believe the current investors have a better sense for the right valuation.

You want investors who maintain their percent ownership.

These investors don’t try to increase their percent ownership because they know it puts them at odds with the founders and management. They know it incents them to use their protective provisions to veto good offers. They know it forces them to signal their sense of the correct valuation.

Your response to supra pro-rata rights is:

“Everybody around the table should be working together to get a high valuation in the next round. Investors and management shouldn’t be at odds with each other in the next financing—let’s create alignment, not mis-alignment.”

Investors who try to decrease their percent ownership in the next round are also bad news. They signal that the valuation is too high. (Angels and seed stage funds are an exception. They’re not necessarily expected to maintain their percent ownership since they may not have a lot of capital.)

What are your experiences with supra pro rata rights?

Use the comments to share your experiences and questions about supra pro rata rights—we’ll discuss the most interesting ones in a future article.